Post Brexit changes to economic base case

Ian Kernohan

28 June 2016

Post Brexit, we have made some changes to our economic base case. The key assumption is that the impact of Brexit is centred on the UK and eurozone economies, rather than a trigger for a global systemic event. This means that a more general global recession can be avoided, which helps the UK benefit from currency devaluation. We have reduced our forecast for UK GDP growth and now assume a mild recession beginning in H2 2016. Sterling will bear much of the burden in the adjustment to the new economic situation, and we expect further weakness. Inflation now looks set to rise a little above target during 2017, with the impact of lower sterling on import costs tempered by the marked slowdown in growth. We expect further policy easing from the Bank of England in Q3, and looking further ahead, we also expect a change in the government’s fiscal strategy, specifically an adjustment in the pace of deficit reduction.

We have also reduced our GDP growth forecast for the eurozone economy, though not to the same extent as the UK. Crucially, this assumes Brexit does not lead to an imminent re-run of the 2011/12 euro crisis. We now expect further policy easing by the European Central Bank.

There is a more modest impact on forecasts outside the UK and eurozone, as a result of the recent financial volatility. The most important change is to the US rate view and we no longer expect the US Federal Reserve to hike interest rates ahead of the November Presidential Election. The main risk to our new base case is that we have underestimated contagion risk to the European financial sector, with Brexit becoming a potential trigger for rapid euro break up.

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.